Spot and Contract Freight: What’s the difference and why it matters

Classification systems make it possible to group and organize data, like freight rates, to compare with other data. In the transportation industry, freight transactions are classified as contract or spot, but the differences between the two can at times be subtle.

The subtlety comes from transportation and logistics strategies becoming more flexible and agile to address supply chain disruptions. The data that shippers, freight brokers and motor carriers use to analyze contract and spot freight rates must therefore be highly accurate, relevant and timely to make the best-possible decisions in a variety of different scenarios.

Sizing up freight contracts

Most freight transactions — between 80 and 90 percent, on average — are executed through contracts. For shippers, contracts are essential tools for budgeting and securing capacity, especially in higher-volume freight lanes. Carriers also benefit from having repeat business from contracts to create network efficiencies and balance freight flows from multiple customers.

Most business contracts for buying products, services or commodities are binding in price and volume. Uniquely, freight contracts are usually binding only in price. Because transportation is a dynamic business, carriers are unable to guarantee capacity for certain days and times in the future. Likewise, shippers can at best provide estimates of lane volumes and load schedules months in advance.

One distinguishing feature in freight contracts is the fuel surcharge. Shippers use the mechanism to offset increased fuel costs for carriers during the term of contracts. Spot transactions are typically negotiated with fuel included in the rate.

Freight contracts are initiated by a procurement process called a freight bid or request for proposal (RFP). Traditionally, shippers conduct RFPs on an annual basis, often a year or two in advance of starting new contracts. Once complete, shippers award freight contracts and begin a months-long onboarding process for new carriers they add to their transportation networks.

The complex, lengthy RFP process has changed significantly in the past few years as supply chains have become nimbler and more dynamic to respond to shifts in consumer buying patterns and disruptions fueled by the global pandemic.

Watching the spot market

Spot market transactions are dynamic by nature. The rates are often negotiated within a few days (or in some cases, hours) of the ship date. A key indicator for rate negotiations and pricing trends is the load-to-truck ratio in any given lane. This time-sensitive ratio often signals changes in spot rates from the balance shifting between demand and capacity.

Rather than go through a procurement process, shippers and freight brokers initiate spot transactions with carriers by searching for capacity in their networks and finding new carriers who respond to load postings from online freight marketplaces or “load boards.”

Traditionally, spot market transactions account for a fraction of total freight volume. Before the pandemic, DAT Freight & Analytics data showed that 13% of shipments were spot moves, but the balance changed to as much as 25% of total truckload freight at times in 2021.

In most cases, loads enter the spot market after falling through shipper routing guides–the electronic catalogs that result from an RFP. Routing guides specify which contracted carriers to give the first right of refusal (load tenders) to for loads in each lane.

If the primary carrier on a lane rejects the contracted load, it goes to the next carrier in the routing guide, and so forth. The deeper shippers go into a routing guide, the more they can expect to pay. When loads hit the spot market, the premium for shippers is typically 25 to 35% per load but can be much higher during a tight market.

Shippers also have lanes they plan to move in the spot market and do not include in RFPs. Those lanes typically have inconsistent or lighter traffic volumes, and often shippers outsource them to brokers or 3PLs.

Shifting strategies

Changing market conditions have blurred the traditional lines between contract and spot transactions. A routing guide failure does not always result in a one-time spot transaction. In some cases, it will lead a shipper to a carrier who wants repeat business, in which case they can use spot and contract freight rate analytics to assist with negotiations for short-term contracts.

If a shipper has certain lanes with major cost increases due to routing guide failures, it could use rate analytics to determine if adjustments are needed to get it closer to spot market rates, which could improve load tender acceptance rates. Similarly, if a shipper is already paying above market rates but not getting requisite service levels, the increased costs will be difficult to justify. Searching for carriers to replace incumbents may be necessary.

Mini-bids can be an effective tool for addressing these and other current needs. A shipper may need to add lanes to access new supplier networks or customer markets, for example, or test new carriers in existing lanes without making long-term rate commitments. As a scaled down version of the annual RFP, mini-bids help shippers find capacity in a more cost-effective manner than going to the spot market.

Another strategy that is becoming more common is for shippers to leverage “dynamic” capacity sources, where loads that fall out of the routing guide are sent to brokers who move the freight at a spot rate aligned with a dynamic pricing index. These brokers may offer guaranteed capacity for loads that shippers do not find coverage for during the normal load tender process.

The shipper will award a lane or set of lanes to brokers that use a trusted spot market index to calculate rates. Brokers who offer these dynamic capacity programs often agree to an upfront, fixed margin over contract rates to help the shipper manage costs.

Making decisions with transportation analytics

Whether you are setting contract rates with annual bids or procuring spot market capacity, solutions that allow you to instantly compare quotes from transportation providers against spot and contract market rates have become essential to transportation decision-making.

Shippers can also use rate analytics to benchmark their internal costs for lanes against contract and spot market rates to identify where changes may be needed to manage costs and improve routing guide compliance.

Using transportation data from a trusted analytics provider will enable you to quickly compare planned versus actual costs down to the lane and carrier level. With this level of freight intelligence, leaders can justify cost increases and change course, as needed, after comparing the costs from the current carrier portfolio with alternative procurement strategies.

To learn more about using freight intelligence to benchmark and optimize transportation strategies, contact the experts at DAT today:

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